There has been ample speculation on whether the Saudis are truly close to tapped out as far as current oil production is concerned. The overwhelming majority believes that declining production is due to falling yields from their biggest oilfield, Gwahar, which has not been fully compensated for by increased output from other fields. A minority argues that the issue isn’t the sheikdom’s absolute capability; that may or may not be close to its limits, but the oils from current fields is sour crude, when for environmental reasons (and a mis-match of refining capacity) demand has shifted to sweeter crude. This cohort argues the Saudis aren’t making it up when they say they don’t see unsatisfied demand for their product and are correctly reluctant to increase supplies.

An even smaller group contends that Riyadh plays its cards very close to its vest and may quite deliberately be sending false signals. Yes, the Saudis have added more wells, which would be consistent with declining productivity of their developed oilfields. But they could also be seeking to maximize returns by choosing to lower output by taking high productivity wells out of the equation for now and relying on more small wells that would allow them to more finely tune output. Consider: if advanced economies are seriously considering carbon taxes and cap and trade regimes, why should OPEC let charges and schemes increase the real cost of its product and let governments and intermediaries reap the windfall? You might as well run the price up yourself and get as much benefit as you can under the circumstances.

The adherents to that view might argue that the current spike reflects a misjudgment of the supply situation: the continued disruption was not anticipated, nor was the failure of Iraqi production to return to close to its pre-invasion levels. But the Saudis need to look as if their hands are tied, even if the situation hasn’t worked out as planned.

Or has it? Consider this item I stumbled across from a post in June 2007, when I noted a complete absence of reporting in the US of an item picked up by the Financial Times:

As the Financial Times called it, OPEC issued a direct threat against the West. The story, the lead article on page one, titled “Drive on biofuels risks oil price surge,” said that if advanced countries make greater use of biofuels (and therefore reduce their oil dependence), OPEC will punish them by cutting production and producing a price surge:

Opec on Tuesday warned western countries that their efforts to develop biofuels as an alternative energy source to combat climate change risked driving the price of oil “through the roof”.

Abdalla El-Badri, secretary-general of the Organisation of the Petroleum Exporting Countries, said the powerful cartel was considering cutting its investment in new oil production in response to moves by the developed world to use more biofuels.

In case you think this might be a wee bit of overstatement on the FT’s part, keep in mind that OPEC has a proud history of disciplining the US through price moves or threat of production cuts. For example, the International Herald Tribune reported in 2003:

OPEC members, joined for the first time by a delegation from post-Saddam Hussein Iraq, unexpectedly agreed Wednesday to cut oil production by 3.5 percent, driving oil prices sharply higher….

“This was a message to Washington,” said Mehdi Varzi, a private energy consultant in London. “You can send a delegation to OPEC, but we control the oil price.”

In fairness, it’s not clear that OPEC could deliver on its threat, since protracted production cuts in the past have lead to cheating by members. Moreover, a sharply higher oil price would make biofuels and alternative energy more attractive. If OPEC really wanted to discourage the development of new fuel sources, it should engineer volatile oil prices. But it is obviously hoping that its threat will be sufficient (and while it may not affect private sector measures, it could deter government support for alternative energy).

The situation certainly has played out according to script. Whether this outcome was by design or luck is anyone’s guess.

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12 comments

“Consider: if advanced economies are seriously considering carbon taxes and cap and trade regimes, why should OPEC let charges and schemes increase the real cost of its product and let governments and intermediaries reap the windfall?”

Very insightful comment.

The cap-and-trade schemes are clearly a rent-seeking activity using fossil fuels as a basis, and consequently are wildly popular among certain groups, with special interests smelling a lot of easy money in the guise of an environmental remedy. It is entirely possible that the Saudis are anticipating that intrusion into their source of wealth, and are reminding the markets of who really controls the monopoly.

“Moreover, a sharply higher oil price would make biofuels and alternative energy more attractive.”

This is historically one reason OPEC kept prices lower; that, and the risk of an economic slowdown. But it is possible that OPEC has called the biofuels bluff. With prices dramatically higher, miles driven only marginally down, and alternatives developing at a glacial pace, they may be coming to the realization that their previous fears were largely unfounded and that the real price ceiling is much higher than previously thought.

If OPEC thinks that carbon pricing or biofuels will reduce demand for oil they’re mistaken.

A carbon price of $50-70 per tonne is all that’s needed to ensure that power from dirty coal is replaced by clean coal, renewables or nuclear. To force a serious reduction in use of oil for transport, the carbon price would have to be about $500 / tonne, which is not on the agenda. As for biofuels, there are obvious constraints on arable land, water and fertilizer.

The only plausible substitute for oil-based transport is an electrified rail network – but that’s still a long way from being seriously considered.

I’m sure you’ve Read Matthew Simmons’ book “Twilight in the Desert.” He makes a very compelling case for the Saudis’ not having a lot of additional spare capacity and for the imminent production decline of some of their major oil fields.

Irrespective, they are only producing sour crude and that’s going to be very hard to refine given the refining infrastructure available.

Anyone have any data on the conversions required to change refining from sweet to sour crude? I know the US has shut down a large number of existing refineries (in the hundreds). The next best sweet producer is Nigeria, but it’s had its own issues of late–not sure if those are “convenient coincidences” or not.

I know that the sour crude is trading significantly discounted to the sweet price, around $40/bbl less, and there is actually a large amount from Iran in floating storage right now.

My question is: who is really tying our hands in not being able to handle this sour crude? I know that we import a great deal of sour from Venezuela already, so we must have some capacity to deal with this.

I heard the Saudis were using water to pump into the wells to get more oil out, but that it was not a good long-term strategy.

I do cheer for alternative fuels, but I think the truly innovative ones have been suppressed, and we end up with highly destructive dreck like corn ethanol.

The Saudis could clear all this up if they wanted. The solution is simple: They just have to allow the engineers to come in and do an independent audit of reserves.

It’s small wonder that they don’t. They’re entirely too much like the 16th-century Catholic Church:

“…the Church didn’t want–didn’t permit–wide readership of the New Testament. Studying it was a privilege they had reserved for the heirarchy, which could then interpret passages to support the sophistry, and often the secular politics, of the Holy See.” (William Manchester, “A World Lit Only by Fire”)

The Arabs have junk oil, which is nice for cruise ships and cargo boats, but increasing this junk supply during a period of increasing inflation is retarded, not to mention the fact, that if the Arabs had clean oil, there are still too few refineries! Mental note, this oil problem is about a highly de-valued dollar under Bush and too few refineries — and of course, too many retarded people driving gas hogs!

I heard an analyst on Bloomberg say that while the Saudis are meeting all demand for their oil, it’s at a high price, very close to the better grades of WTI and Brent.

I thought of another reason they might want to keep prices high. When Bush wen over there to ask them to drop the price, his motivation might have had to do with an attack on Iran. If the Saudis were to pierce the bubble before an attack, it might lessen the blow. In that same trip, he visited Israel where he allegedly gave the OK for them to attack.

Maybe the Saudis would just assume put the kibosh on an attack that could strengthen the hand of their own extremists? Oil at $138 makes an attack close to economic suicide for the US.

I read part of “Twilight in the Desert”…a bit dry but very interesting read…good to fall asleep to!

One factor to consider in increasing output is that you risk damage to the well.

First, a “cap” of natural gas can form at the top of the well when the pressure drops (think of opening a 2-liter of soda that you just dropped)

Secondly, wells are not just a big swimming pool of oil underground…while Ghawar is probably closest to this, most of the other Saudi wells are more “complex”, meaning different pools at different depths.

It is much more efficient in the long run (higher total oil recovery) to pump slow and steady, and let the groundwater push the oil up to the well head, if you pump water (currently at like 11 million barrels per day) to maintain pressure, you can cut off outlying pools, and start getting a much higher water “cut” much sooner.

The Arabs likely have another easy-to-pump field that they mothballed…but this is probably being saved for future generations.

Plus, OPEC members have every reason to lie about their reserves, as their quota allocation is based upon stated reserves.

If oil were presently $200 a barrel then there would be even less demand. I find the Saudi’s rationale that they shouldn’t raise production because there are no buyers just a bit much to swallow. What they’re thinking but not saying is that there is no demand for more oil at the current price and they’re just happy as clams with the current price.

Give me a break. OPEC and the Saudis have been lying and overproducing forever. OPEC nations are among the least democratic and most corrupt on our blue ball in space. Suggesting that the Saudis are managing production in this way is akin to suggesting that Nigerian kleptocrats stole the money to prevent the People from wasting it on frivolous consumer items.

Saudi was supposedly able to turn the taps up to 12 million bpd almost overnight. Instead they have been investing in the largest number of new wells in the world over the past year. All they have to show for it is a measly 300m bpd. Ghawar is dying. They destroyed it by turning it off once and on again too high when they ran up to 12 million a few years back.

The rest of OPEC is maxed out or has heavy, sour crude which is not as desirable. That said, there is a price for everything. It is not as if heavy sours are selling for fifty percent of the price of Brent. Dubai, for example, is a mere 5$ cheaper than Brent. Hardly a pariah of the oil market.

I believe the frightening truth is that Saudi and OPEC production has peaked on existing fields and wells. OPEC oil consumption is rising rapidly. New oil is extremely expensive to produce (think Tupi which is six miles down from surface, under tremendous pressure, and at temperatures which melt titanium drill bits).

The drivel about Saudi punishing the world for developing biofuels is plain stupid. Saudi Arabia learned the lesson in the seventies when the OPEC embargo spiked prices. US consumers lowered their thermostats, put in insulation, and bought smaller cars. After prices came down (at least in real terms), the thermostats did not rise much, the insulation was NOT ripped out, and mileage requirements were legislated. Only much later, after years of bubbling inflation, did we circumvent mileage laws and start driving trucks (SUVS, hummers, etc.). The result, along with Chindian growth, was an explosion in demand and prices.

Now we are scrambling again to raise mileage requirement, develop hybrids, use clean coal, etc. Why in God’s name would Saudi push oil prices UP to stop us from doing all that?

Had you read the piece, it pointed out the Saudis have every reason to drive up the price themselves, since governments around the world are moving toward carbon tax and cap and trade regimes to reduce the use of fossil fuels of all kinds. Why let governments and private traders benefit from discouraging use of your big product if you can run up the price yourself, achieve the INEVITABLE result of reduced usage, but at least reap the economic rent? Seems like a no-brainer to me.

And it would also be in their interest to do so gradually and look like the matter was out of their control.

Now the post states clearly, most observers believe that Saudi Arabia is capacity constrained. But other experts, including Dr. Richard Pike, who worked in the oil industry for 30 years and now heads the Royal Society of Chemistry, argues that the methodology used for estimating proven reserves understates the total by 50%, and this is well known within the oil industry. However, according to him, they choose not to advertise this fact, since they benefit from higher prices.

And Pike is no oil industry shill; in fact, he think the fact that oil is more abundant than it is commonly believed to be is a very bad thing, because it will delay switchover to environmentally friendlier energy sources.

That does not tell us what is up with the Saudis, but was included to illustrate that basic facts are very much in dispute.

Yves, In 2000, the Saudis and some others changed their pricing method – Saudi Aramco applies formula pricing for crude oil sales adjusted monthly to the following benchmarks and markets: (a) the Brent Weighted Average (Bwave-1), which covers the extended trading session as the basis for its crude sales to Europe and gives protection against price distortion; (b) Dubai/Oman for the east of Suez, and (c) spot WTI for the US and the Bahamas. …The prices of WTI and Bwave-1 are set by futures trading on NYMEX and the IPE. ( APS Review Oil Market Trends, 8 October, 2007)

Now it may be that they have control over the futures markets but I think it more likely OPEC remains a convenient scapegoat.